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May 28, 2008

Bending the rules

Some rules were made to be broken. Christine Benz of Morningstar highlights some misleading conventional wisdom.

"It's possible for a fund to have an unblemished record of positive calendar-year returns but plenty of losses over other 12-month periods," she says. Benz says it's more important to watch absolute returns. Underperforming funds aren't always deadweight so don't drop a fund just because it's a had a bad year or two. Benz recommends holding onto a fund as long as it retains its investment thesis.

It's hard to ignore gut feelings, but risk tolerance shouldn't be the number one factor when considering asset allocation. Time horizon, savings rate and expected returns, as well as the size of an investor's nest egg, are more important, Benz says. Likewise, moving assets into cash when the market takes a dive may bring immediate relief, but investors are then faced with deciding when to get back in the market. Again, looking at how long clients have to invest is the best way to determine asset allocation.